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Carbon Leasing

Saskatchewan Soil Conservation Association

Box 1360, Indian Head, SK S0G 2K0

Ph: (306) 695-4233; Fax: (306) 695-4236

Web: www.ssca.ca; E-mail: This email address is being protected from spambots. You need JavaScript enabled to view it.

Prepared By: John Bennett and Dave Mitchell

March 27, 2003

Summary

  • Agriculture soil sinks will be a critical component of Canada's efforts to reach its greenhouse gas emission target under the Kyoto Protocol
  • Leasing of temporary credits (TERC) for agricultural soil sinks will be the best policy because it provides an acceptable liability situation for the farmers who will be creating and maintaining the sinks and addresses the potential reversibility of agricultural soil sinks.
  • For a TERC market to be successful and beneficial to farmers, the farmer/landowner must clearly own the carbon credits associated with carbon stored on their farms.

Leasing Carbon

To cost-effectively meet its greenhouse gas emission target under the Kyoto Protocol, Canada will need to use all its possible agricultural soil sinks. Policy-makers must recognize that for agriculture to make a significant contribution to Canada's climate change strategy, the widespread cooperation of thousands of individual farmers is a requirement. Any accounting system designed to generate a substantial pool of emission offsets must address all of the incentives and disincentives that will affect farmers' decisions.

Policy-makers must also recognize that biological sinks - and any Emission Reduction Credits (ERCs) they generate - can be lost as well as created. The removal and storage of CO2 in biological sinks entails the creation of a new carbon stock, which could become a source of emissions at a later date. Forest sinks, for instance, can be created over time, but can very quickly be lost by natural (fire) or man-made events (harvesting). Similarly, agricultural soil sinks can be lost either by choice or by accident. Many factors beyond a farmer's control can cause the loss of a sink, natural events such as climate change that reduces carbon storage, or man-made events like a return to tillage to control herbicide-tolerant plants or crop diseases.

The offset markets that are created to achieve Canada's climate change policy must respect the dynamic nature of sinks, particularly the fact that, to fulfill its role, a sink must be maintained over time, and can fluctuate unexpectedly. It would be foolish for policy-makers to separate sink creation and sink maintenance. Trying to market sink offsets without addressing the maintenance issue would be like expecting to buy a car with a perpetual maintenance contract - great for the buyer, but an unreasonable liability for the seller. Any market for ERCs that ignores the issue of maintenance asks the farmer to assume an unreasonable level of liability, because when he or she "sells" the sink, the farmer is essentially committing to maintain it in perpetuity. The implications of this transfer of liability are elaborated in "Emission Trading and the Transfer of Risk" (Bennett and Mitchell, 2000).

Instead of two pools of offsets we should treat all agricultural sink offsets the same, with a contract regime that addresses the maintenance issue as well as encouraging sink creation. A simple approach would be to view all offsets as Temporary Emission Reduction Credits (TERCs). These credits would be comparable to ERCs, the difference being that TERCs would have a time value, while ERCs would not. TERCs could be integrated into the Canadian ERC market.

To explain how TERCs would function, let's adapt an analogy discussed by Marland, Fruit, and Sedjo (2001). According to their analogy, a car-owner (an emitter of greenhouse gases) can lease a garage (a carbon sink, created and maintained by a farmer) to park his car (his surplus emissions). At the end of the contract, the car-owner can choose to renew the lease, or find another place to park his car. The car-owner may have taken this time to find a better lease agreement elsewhere, or perhaps built his own garage, or decided to park on the street and suffer the regulatory consequences. Ideally, the car-owner will have found another mode of transport (reduced his emission levels). If the first garage is no longer needed, it would become available for another motorist to lease. There is also the possibility that the garage owner (farmer) may need the garage himself, to offset his own emissions. It is important to understand that a "garage" can be lost to acts of nature, even if the farmer wishes to maintain the sink.

A TERC could represent the storage lease in this example. The lease value of a TERC would be significantly lower than - but correlated to - the value of ERCs. The TERC would be based on the maintenance of a carbon sink for a specified period of time, unlike ERCs, which are sold only once, with the understanding that they are permanent. When the lease expires, the lessee must repay the leased credit with an ERC. This ensures the atmospheric integrity. If the leasable carbon sink is available, the lessee could renegotiate with the farmer to lease it again and, in that way, repay the previous TERC with a new TERC.

One example of a maintenance-based carbon-sequestering arrangement is the carbon storage lease between PNWDSA (Pacific Northwest Direct Seed Association) farmers and Entergy, an energy consortium. In this agreement, the PNWDSA farmers agreed to capture and store CO2 and lease the resulting offsets to Entergy. The size of the storage space and the length of term are spelled out in the lease contract.

If the federal government desires to stimulate farmer participation in a national strategy to offset and reduce emissions, steps must be taken to reduce farmers' exposure to risk. Given the great uncertainties of climate fluctuation and commodity prices, asking farmers to commit to maintaining substantial carbon sinks in perpetuity is simply unreasonable. If, however, a lease arrangement were based on previous action (i.e., on carbon that has already been stored for a period of time), the risk could be reduced to a more manageable level.

To elaborate, let's refer to the following graph:

carbon1

The above graph plots the life of a carbon sink. The y-axis represents the amount of carbon sequestered at any given time (x-axis). Sequestration begins with the creation of a sink in 1990 - say, with a switch to zero-tillage or direct seeding. Carbon accumulates over the next number of years, until the sink reaches its saturation point around 2004. This level of carbon storage is maintained until the sink is "cracked" - say, with a return to conventional tillage in the future - and the stored carbon begins to escape into the atmosphere as CO2.

A TERC is best understood as the removal and storage of an emission for a given period of time - say, for five years. With a temporary lease-based strategy, whatever storage space has already accrued could then be leased out on a five-year basis. It is important to remember that only the units of storage that have already been stored for that period of time would be leasable. Under such a system, TERC availability could be predicted with confidence, reducing liability for the farmer to a much more manageable level.

The red bar in the above graph represents the quantity of carbon that is sequestered over a given five-year period, while the light blue bar represents the quantity of carbon that has already been sequestered in the previous five year period, and is therefore available to lease. The offsets created before 1993, for example, would generate TERCs leasable in 1993-97. TERCs for each of these vintages, issued in 1993, would provide emission storage for five years (until 1997), after which they would expire, potentially to be leased again for another five-year period.

The additional carbon that is sequestered between 1993 and 1997would be added to the leasable pool available for the 1998-02 period. When the sink becomes saturated, no additional TERCs will be added to the pool, but the steady income generated by the periodic expiration and re-issue of credits will encourage the producer to maintain the carbon sink for as long as possible.

The focus on carbon that has already been sequestered would ensure atmospheric integrity if the sink were lost: only carbon that has already been removed from the atmosphere would be credited against new emissions. It would also serve to encourage early action in sink creation, because the earlier a sink is created, the more TERCs that would be available to lease.

The following graph will help explain how the supply of TERCs would track the loss of the sink and maintain integrity.

carbon2

This graph represents a sink that grows until 1997 but starts to decline in the 1998 - 2002 period. This decline would mean that only some of the TERCs issued in 1998 and expiring in 2002 (representing carbon that was sequestered from 1993 to 1997) would be reissued for the 2003-07 period. Whatever credits have been lost over the course of a five-year period (yellow bars) will simply become unavailable to be leased out in following years, without threatening the integrity of current TERCs.

The shift to a market-based system of incentives for farmers to adopt carbon-sequestering practices represents both tremendous opportunity and tremendous risk for farmers. Unless farmers take an active role in shaping the policy currently under development, they may be faced with a system that in fact discourages early action on climate change, while punishing farmers who sell the credits generated by their sinks by locking them into inflexible long-term agreements. A system based on temporary credits, however, promises the best of both worlds: maximum flexibility for farmers, and atmospheric integrity for all of us.

Leased Carbon in the National Accounts

Now that Canada has formally endorsed the Kyoto agreement, the federal government is confronted with the twin tasks of, on the one hand, significantly reducing or offsetting GHG emissions, and, on the other hand, quantifying exactly how much carbon dioxide has been kept from the atmosphere through our efforts, for Kyoto accounting purposes. To account for the carbon that is being sequestered in agricultural soils, the Canadian Government has proposed an accounting system that recognizes two different "offset" pools. One pool will be designated as "business-as-usual" offsets, and will simply be claimed by the government and subtracted from the national emission reduction targets. The other pool of offsets - those that are generated after a certain date - will be credited to the land-owners to trade as they see fit, adding significant value to their operations.

This "two offset pool" approach to carbon accounting will likely have the opposite of its desired effect of generating a substantial pool of offsets - it will only discourage producers from sequestering carbon, and reward inaction on climate change. It will fail to maximize the full potential that agricultural soil sinks could provide to help Canada meet international GHG reduction commitments. Such a failure would mean higher costs for domestic emission reductions, and a much greater reliance on offsets purchased offshore.

A more sensible approach, from both a farmer's perspective and an environmental perspective, would be to treat all of the agricultural sink offsets that Canada will use to meet international obligations the same. The Temporary Emission Reduction Credit (TERC) described earlier provides a useful vehicle to trade the resulting sinks in a way that provide maximum incentive to farmers to create and maintain the agricultural soil sinks. However, for a TERC market to be successful and beneficial to farmers, the farmer/landowner must clearly own the carbon credits associated with carbon stored on their farms.

References

Bennett, J., and Mitchell, D. 2000. Emissions Trading and the Transfer of Risk: Concerns for Farmers. Climate Change Handbook for Agriculture 2000. Centre for Studies in Agriculture, Law, and the Environment (CSALE), Saskatoon, SK. Available at http://www.ag.usask.ca/centres/csale/cchpolicy.PDF

Marland G., Fruit K. and Sedjo R. 2001. Accounting for Sequestered Carbon: The Question of Permanence, Environmental Science and Policy 4 (2001), 259-268.

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